Modernizing the Way We Source
The IT sourcing landscape has evolved over the last 20 years, and the pace of change is ever increasing. The monolithic five-, seven- or 10-year contracts signed in the last decade may not be so well-suited to today’s digital world. As we enter a new decade, it is time to consider whether to replace or rework them.
CIOs, CDIOs and IT Procurement specialists must now deliver IT solutions quicker, cheaper and with little or no long-term commitment. This is fine for the startup community, digital enterprises that have grown organically or organizations with already-established digital transformation programs. But what about enterprises that are just starting on their digital journey? They cannot just put their contracts in the shredder and start again.
Legacy application and infrastructure support contracts will have to co-exist with their digital counterparts (XaaS, automation, DevOps, etc.) for the foreseeable future.
Why Do Contracts Need a Digital Makeover?
We constantly hear how digital transformation programs require a new approach to sourcing and how the digital ecosystem is dependent on new niche players in the market as well as traditional multi-tower system integrators. Organizations are at different stages of the digital journey and most will have a blend of digital and more traditional business models or services.
Digitization not only is accelerating the pace of technology change and opening the market to smaller agile providers, startups and crowdsourcing, it also is bringing new concepts such as “DevOps,” “fail fast,” “minimum viable product,” “artificial intelligence” and “X as a service.”
Don’t be fooled by enterprises that claim their move to the cloud enabled them to slash operating costs and drive up flexibility to react more quickly to customer demands. More often than not, large organizations are still locked into and constrained by legacy and proprietary applications and infrastructure.
When an outsourcing contract is written, it typically reflects the current challenges facing the enterprise and focuses on the here and now. Most of these contracts are never refreshed to consider the new requirements of a changing IT world.
Think back just five years and consider how much has changed. What is driving this change?
- The need to take more cost out of the “run.” First- (and often second-) generation agreements have already taken most of the internal costs out of internal IT teams and replaced them with more efficient and cheaper outsourced models, leveraging provider scale, best practices and lower-cost locations. Now enterprises need to seek other ways to reduce costs and free up capital for “change” and “transform” programs.
- The need for flexible pricing models. Fixed price for a fixed scope results in expensive change requests. Organizations require far more agility and flexibility to meet constantly changing business demands.
- Business taking back control of IT. Business units are requiring more autonomy over their IT sourcing to leverage advances in technology to either gain a competitive advantage or drive down their IT operational costs. At the same time, they are demanding a quicker time to market and more choice over platforms or solutions.
- The “X as a Service” model. Consumption-based services are becoming the dominant force in IT and have driven dramatic changes in the role IT plays in the enterprise. It is no longer the sole domain of the IT department to design, build, test, run and maintain business applications, whether systems of record or systems of engagement.
Top 5 Considerations for a Contract Digital Makeover
Enterprises that are assessing their IT service contracts for a possible digital makeover should look closely at the following five areas:
- Scope flexibility – does the scope still match the needs of your business?
- Pricing models – are they still fit for purpose?
- Service levels – do they drive the desired behaviors and results?
- Data at the core – what data should you or your service provider be capturing?
- Provider ecosystem – how do you want your providers to interact?
1. Scope Flexibility
When describing services in the form of a service catalog, streamline the procurement of those services based on a simple set of parameters (activity, priority, performance level required, etc.). Long, verbose service definitions are often obsolete soon after they are included in the contract as the business needs evolve, requiring IT to play catch-up to deliver according to business expectations. Too often we find ourselves deep in discussion with the provider as the service definition and related service level differ from what was envisaged when the contract was signed all those years ago.
For application maintenance and support (AMS) contracts, we see an ever-increasing number of commercial-off-the-shelf (COTS) applications such as SAP and WorkDay being delivered “as a service.” This requires a different approach that traditional bespoke applications. The maintenance effort shifts from coding, bug fixing and patching to configuration, tuning and ensuring that regular feature and technical upgrades are planned with the business and IT functions. AMS service providers have standard support models for these applications, so offering a service catalog-based model makes sense.
It is more cost effective to leverage shared services teams for this type of support, but be sure to complement it with dedicated resources who are familiar with the enterprise’s systems and business and can offer hours for minor enhancements.
Another area where the delivery model can differ is for Agile development and/or DevOps. Under these delivery models, the service provider offers a fixed fee for maintaining an ongoing capacity pool with the option to flex up or down depending on demand. Enterprises contract for a fixed level of output (e.g. story points) per month, and the provider and enterprise work together to prioritize demands and schedule changes into releases.
Enterprise clients that wish to exploit the provider’s innovation capabilities can do so through the creation of innovation hubs, test labs or centers of excellence. The “fail fast” model can quickly progress from a proof of concept to a minimum viable product that can be deployed into a limited production environment and then quickly industrialized for global consumption.
2. Pricing Models
Most outsourcing contracts comprise one or more of the following pricing models:
- Fixed price for a fixed scope
- Fixed price for an “all you can eat” managed service
- Variable price based on price x quantity (P*Q) – with or without ARCs/RRCs
- Fixed effort (e.g. three scrum teams per month)
Each of the above models has its benefits, but as soon as you wish to change the scope of the service, you will have to make adjustment to the price. One method is to engage in a never-ending continuum of renegotiation cycles, which can become a battle between each party’s view of where the price point should be.
If you wish your provider to really embrace “partner” status, you will need to commit to a minimum level of spend per year (base level). This base level should be significantly lower than forecasted spend but high enough to gain the commitment of your provider. As the business and technology landscapes change, the IT services required and how those services are to be delivered is also likely to change. Work to ensure you can flex services up and down while still maintaining the overall base committed spend.
3. Service Levels
Traditional performance metrics in terms of service levels, key measures and key performance indicators drive a certain behavior, particularly when there are potentially expensive penalties on the line. Most providers focus primarily on meeting service levels at all costs, even when not in the enterprise client’s best interest. Some providers also blame a failed service level on the enterprise’s inability to fulfil an obligation (either contractual or implied). Enterprises must regularly review the contractual service levels and adjust them to reflect changing business needs or focus areas.
We suggest converting traditional tower-specific service level agreements (and their associated service credits and earnback regimes) into outcome-based measures or experience level agreements (ELAs), which are aligned more closely to the business needs and can even adopt a gainshare approach for measurable business improvement resulting from IT. This gives the provider a vested interest in the client’s success and is motivated to over deliver and propose service improvements to generate a better outcome.
Here are some questions to answer when making sure your service levels drive the desired behaviors and results.
- When was the last time you reviewed your contractual SLAs for relevance?
- Do they drive the right provider behaviors?
- Are they there purely for executive oversight that IT is doing their job?
- Have you inadvertently created a cottage industry of vanity performance metrics?
- What would happen if you stopped measuring and reporting service levels for 3 months?
4. Data at the Core
The capture, analysis and use of data is where enterprises should place their bets. Data analytics is driving rapid advances in cognitive computing, machine learning, artificial intelligence and big data. Much of this data is sourced from legacy systems at the heart of an enterprise. Twenty years ago, when we had OLAP, data warehousing, business intelligence and decision support systems, we did not worry too much about how the data would be exploited outside of its original purpose. In the modern enterprise, data is key to unlocking the neural networks that drive deep learning and help computers “think intelligently” to make decisions that improve business performance. The enterprise data model (EDM) plays a major part in designing these networks of seemingly random and unconnected data points.
One of the most valuable IT roles in an enterprise today is that of the data scientist, but, unless the data structures and infrastructure are in place, there will be little value derived from the role. Legacy applications and infrastructure must provide much of the data on which these models depend. Many providers will claim they use analytics internally to constantly assess the state of their clients’ data and make decisions accordingly, but what you really want is access to that data so you can incorporate it into your wider EDM and make insightful connections between seemingly unrelated systems.
Data privacy and security are always paramount, but legacy application and database providers should be contractually committed to provide access to the data they capture about the enterprise, its people and its customers.
5. Provider Ecosystem
It is rare nowadays to find a single provider delivering all an enterprise’s IT functions. It is far more likely that multiple providers will be working in parallel with inhouse functions to deliver value to the business. This approach requires all providers – including niche players and established providers – to work collaboratively in the enterprise’s best interests. New contractual clauses compelling the provider to collaborate and adopt a “fix first, settle later” philosophy are crucial in these relationships. Some enterprises require all providers to sign off on a set of general terms or a separate collaboration agreement, which contains a multi-party element to ensure consistency of behavior across the provider ecosystem.
You may have exit clauses in your contracts that require you to pay some form of “termination fee” for an early termination of the contract for convenience. Many enterprises like to avoid ending a provider relationship early, especially in cases that involve large fees. If you do find yourself in this position, the key is to re-negotiate these exit clauses before you need to execute them. A good method for removing these clauses is to wait until a discretionary project is being estimated and make any subsequent award of the discretionary project work conditional on the removal of the termination fees.
Renegotiating and Re-engineering Your IT Services Contracts
Now that you have considered all the above, it is time to plan your digital makeover and reach out to your incumbent providers to begin the process of renegotiation and re-engineering your IT services contracts.
A digital transformation is a journey, not a destination. The first step on that journey is to take a look at the here and now and determine what will hold you back. Do you have provider lock-in clauses in any of your contracts that make it difficult or expensive to terminate the contract, break out different services or simply change the delivery model? If you answer yes to any of these, then you are not likely ready to take the next step and may need to think about how you want to recast your sourcing landscape.
A good outsourcing relationship will offer both enterprise and provider mutual business and financial benefits balanced between the parties. With this in mind, find out what your provider will want in return for a renegotiation of the contract? Do they seek a longer term? Increased footprint or wallet share? Higher margin work? Implementation of new tools and technologies? Once you know their objectives, you can use that to design your digital makeover. Share your ideas, plans and concerns with your providers. They are also keen to help you evolve and will want to retain as much of your IT spend as possible. If your contract is due to naturally terminate in 18-30 months’ time, you have the maximum leverage to renegotiate a new deal.
ISG’s Sourcing Solutions Team understands the demands that digitization places on enterprises and their sourcing requirements and is well positioned to advise you on how best to futureproof your sourcing strategy and contracts. Our experienced sourcing advisors and digital experts can help your organization undertake a digital health check of your current contracts and recommend key changes. We also can help you negotiate favorable terms to reduce costs, increase sourcing flexibility and stimulate greater interest from your incumbent providers.
Contact us to learn more.